Unemployment Insurance and Optimal Taxation in Search Models of the Labor Market
In many search models of the labor market, unemployment insurance (UI) is conveniently interpreted as the value of leisure or home production and is, therefore, treated as a parameter. However, in reality, UI has to be funded through taxation that might be distortionary. In this paper, I analyze the welfare implications of different taxation systems within two equilibrium models of unemployment: random search and directed search. In a random search model without taxes, efficiency is typically not achieved, unless the so-called Hosios condition is satisfied. If the bargaining power of firms is large, a lump-sum tax can discourage firms from entering and improve welfare. In a directed search model without taxes, constrained efficiency is always achieved. Since firms “direct” workers to apply to them by posting wages, raising UI funds in a lump-sum manner always distorts the efficient allocation, as it gives firms an incentive to be excessively aggressive in their attempt to maximize the probability of filing up their vacancies. I discuss two ways through which this externality can be internalized and efficiency can be re-established.
|Date of creation:||24 Sep 2012|
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